Prices in the European Additional Tier 1 market made a tentative recovery on Tuesday as investors, reassured by statements from the EU Single Resolution Board (SRB), the EU Banking Authority (EBA) as well as the Bank of England on the asset class, dipped their toes back into the market.
The decision to wipe out SFr16bn (US$17.3bn) of Credit Suisse's deeply subordinated debt over the weekend while leaving shareholders with a stake in a future recovery to facilitate a shotgun wedding with UBS shook the market on Monday, leading to what bankers described as indiscriminate selling of AT1 paper.
However, authorities in Europe and the UK were quick to step in to calm investors' frayed nerves, helping a recovery in bond prices.
“We did hope that EU regulators and the UK would come out fairly quickly, but they were much quicker than expected, so in that regard they should be applauded," said Eoin Walsh, a partner for portfolio management at TwentyFour Asset Management. "I think it’s down to the fact that we saw incredible volatility in the AT1 market. The statements had a big impact. The market rallied quite significantly after the statements, and that followed last night and again this morning. AT1 prices are up three to five points.”
A €750m 8.25% AT1 issued at the beginning of the month by CaixaBank was quoted just above 87, for example, having opened at 82.75, according to Tradeweb, while a €1.25bn 7.375% from BNP Paribas was at 91.75, up from 87.50 on Monday.
"Helpfully, the other European regulators (EBA, SRB, ECB, BoE) have already confirmed their resolution approach – that equity instruments stand to first absorb losses before any AT1 writedowns – this should provide some assurances to investors on the European regulatory framework and support the reopening of the AT1 market to new primary issuance over time," Amundi wrote in a note.
"This communication should partially mitigate the AT1 bond pricing storm. Going forward, we confirm our view that the European banking system is strong and that current repricing will generate attractive opportunities for the most stable banks."
One debt syndicate banker remained cautious, however.
"Some [investors] think it’s just an episode, nothing major, it’s more of Swiss problem rather than a world problem," he said. "Others see it differently and question much more the content and value of AT1 as an asset class. [The wipe-out] has evaporated a lot of trust in the system, especially a lot of trust in the bailout regime that we’ve tried to establish over the last 15 years."
He said what happened to Credit Suisse looked different from how the market had expected banks in crisis would be reshaped.
"Definitely, AT1 will be much more challenging going forward, and I would expect many investors who burnt their fingers on the Swiss ones either would think twice, will only buy if it’s rocking cheap, or would just retract from the market for the time being,” he said.
Silvia Merler, head of ESG and policy research at Algebris Investments, said Finma's decision to write down CS's AT1s was a policy mistake that may have longer-term consequences for the credibility of the Swiss banking resolution framework, as it introduced significant uncertainty on the hierarchy of Swiss banks’ creditor resolution and restructuring.
JP Morgan analysts shared her view, writing that, while it was understandable that there was an adverse market reaction in AT1, they thought Swiss AT1 was more vulnerable to regulatory risk in the future.
"Given the valuation points that we had reached, which were already quite low, we suspect that risk premiums in the asset class will erode, especially as resolution for EU banks has at least been more consistent, with Banco Popular AT1 impairment being consistent with full shareholder impairment as well," they wrote. "We note EBA guidance that 'common equity instruments are the first ones to absorb losses', suggesting that only a Swiss AT1 'regulatory risk' premium will be required going forward."
Wider notching?
Finma's action could have rating repercussions, with Moody's stating on Tuesday that it noted Credit Suisse's "AT1 instruments were written off before full utilisation of shareholders' equity".
"The rating agency will evaluate any implications of such actions for UBSG's AT1 instruments' notching as part of the outlook process," it wrote, after changing UBS' Aa2 long-term deposit rating and its Aa3 long-term senior unsecured debt ratings to negative outlook. The Swiss lender's AT1 debt is currently rated Baa3.
S&P also revised the Swiss bank's holding company outlook to negative from stable, affirming it at A–.
On the other hand, Credit Suisse's Baa2 group rating was place on review for possible upgrade by Moody's, while S&P placed the Swiss bank's A– rating on CreditWatch positive.
"We consider the UBS group to be materially stronger than the Credit Suisse group," analysts at the agency wrote. "The acquisition will therefore benefit it by stabilising its franchise, as well as its funding and liquidity. It should also prompt a strengthening of Credit Suisse's governance and risk management standards."